Asymmetrical Information - Megan McArdle

04.24.13

The Real Problem With the Internet Sales Tax

People who are saying this is no big deal aren’t thinking things through.

This will be your second post today on the problem of collecting sales taxes on Internet transactions, because after I wrote the first post, it became clear to me that most people who are writing about it do not understand why this is onerous for small business. I mean, sure, hey, there's all these different rates, but that's what software is for!

It's pretty obvious that most of the people writing about the sales tax have never run a small business. They are thinking about the transaction from the point of view of the consumer, where you punch in what you want to buy, and the software painlessly calculates the percentage for you. Few of the commentators I've read have asked themselves what happens to the money after the software has collected the money. Do the sales tax fairies simply whisk it off to the nice folks at the state tax department?

Sadly, no. Rather, as an SBA guidebook for small businesses points out, you have to file a tax return with each and every locality for which you have collected tax. The bill streamlines this a bit, but you've still got to keep 50 states’ worth of records and file 40-odd states worth of returns. 

Generally, states require businesses to pay the sales taxes they collect quarterly or monthly. You’ll have to use a special tax return for sales taxes, and report all sales, taxable sales, exempt sales and amount of tax due. Not paying on time can result in penalties. As always, check with your state or local government about the process in your location.

For Amazon—the actual target of these laws—this is trivial. Its staff of crack accountants can probably roll these things out before their Monday-morning coffee break. For a small vendor, however, that's a whole lot of paperwork. Imagine being a small eBay vendor that has to file a different set of tax returns every quarter or every month, depending on who happened to buy your handmade toaster cozies. The bill makes this slightly easier by exempting the smallest businesses and saying that you only have to file one return per state. But that's still hours and hours of work per month, for folks who are probably already working pretty damn hard.

This bill, in fact, is good for Amazon—it kills off their small-fry competitors who can't afford the staff accountants (or the software) to file 46 returns every month. And it frees them up to open warehouses in more states, the better to minimize their shipping costs. Presumably, that's why they're in favor of the bill.

But it's going to be hell on sole proprietorships and other small businesses that can't afford the compliance overhead. Anyone who has had to file income tax returns in two states can imagine why you might not want to file in almost 50—monthly.

Now, the sales tax return is not as complicated as an income tax return. But it's still time consuming. It opens you up to audits by lots of different tax departments and (more likely) lots of time spent on the phone straightening out paperwork mistakes. And there are always paperwork mistakes. My mother paid employment taxes for one weekly visit from a cleaning lady, and it cost her almost as much accountant time as her personal taxes from being a self-employed real estate agent.

And you know what happens if you screw up your sales tax returns? They charge you penalties and interest, and if you don't pay, they seize the money from your bank account. (Not entirely unfairly: not paying your sales taxes is a favorite method for small businesses to try to overcome a cash flow problem. The pokey is the favorite destination for these tax cheats.)

This may be particularly likely to happen if you are not a local resident or a big business with an extensive lobbying budget and therefore do not have a representative in the state legislature who can be called to complain that the tax department is persecuting you.

This is death for a small business in the fledgling stage.  

It doesn't seem worth hassling them to get a few extra bucks out of Amazon. Some of those small businesses are the future big businesses of the world. More of them are a way for hardworking people to achieve the American Dream of being their own boss. All of them are contributing to the general welfare. At least until we kill off their Internet sales by demanding they file dozens of monthly or quarterly tax returns.

 

Update: Can you build a service that outsources sales tax collection? Yes; indeed, they already exist. But they are not free, though it looks like the law will make some free options available. You still have to manage the vendor and the classification of everything in your inventory under the tax laws of many states. And as far as I know, they do not exempt you from the need to hassle with state officials if there's an error on your side, or theirs, any more than using TurboTax, or an accountant, means that you can ignore an audit. You may get the state to agree that you have no liability—but you have to prove there's no liability.

On a fairer note, a number of people argue that almost no one on Etsy does significant revenue, so I've changed it to eBay.

 

This article has been edited to point out that very small businesses will be exempt.